The psychology of M&A deals: four mindsets to avoid

The risks and poor outcomes associated with many M&A projects have been well documented, delivering a clear consensus.

Large deals have especially bad outcomes when viewed from a shareholder perspective. Bad strategy, significantly over-paying, and botched integrations usually get the blame.

However, it is not simple bad luck that bad deals are completed. Someone made the decision to go ahead at each stage – and they probably did so despite accumulating evidence suggesting that the deal would destroy value.

The price might have escalated due to competitive bids, due diligence may have uncovered significant risks, or it may have become apparent that integration would be more difficult that originally believed.

All of this would mean the deal was less likely to deliver the intended benefits. Yet the deal was progressed nonetheless.

It doesn’t have to be this way. The buyer still has the option to pull out until the deal is actually signed. Yet CEO’s are reluctant to pull bad deals.

Here are four mindsets that influence CEOs to continue, despite growing evidence that the benefits from the deal are deteriorating and they no longer make sense.

1 The risks of trying to create a legacy

With more significant deals there is often the issue that leaders want to leave a legacy. That encourages them to pursue a deal that transforms the organisation – for better or for worse.

It is a dangerous notion and if not well executed, it often leaves a huge burden that their successors have to manage.

Remedies may include selling off the acquisition, usually at a substantial loss. We saw this with US telecoms infrastructure provider AT&T selling its mast business to fund a deal to acquire content producer Time Warner for $106 Bn in 2018.

The deal was a disaster halving the AT&T share price which only recovered when they subsequently sold it off.

The minute I hear the word ‘legacy’, I start to worry about the likely outcome. This mindset replaces the business case for a project into a personal crusade that is designed to leave a lasting memory, instead of being driven by the potential benefits.

As a result, it usually leaves a major white elephant for the next management team.

2 Why CEOs become blinkered

‘Deal focus’ involves making a decision at a very early stage to acquire a target irrespective of the cost and risk, which are viewed as almost irrelevant.

The leader is so keen to do the deal that they ignore any cautionary information and only take on board supportive data and views.

Anyone who opposes the deal internally is seen as a ‘blocker’ or ‘negative’, rather than offering objective insight. And this intolerance of any negative findings can continue for years after the deal is completed, despite obvious signs of failure.

Other managers and advisors soon realise that their role is to support the deal, which leads to a ‘Groupthink’ approach. This can go so far that the option of not buying a particular target can no longer be discussed openly.

Indeed, the finance team may even discern that they are expected to project benefits to justify the deal.

When this happens, it is no wonder that integration teams fail to deliver the forecasted benefits. They usually had little or no say in determining what can be achieved.

The fact is that most decisions improve when they are challenged in a constructive and critical way, but some cultures make this almost impossible.

3 ‘Deal heat’ leads to bad M&A decisions

Getting a deal ‘over the line’ is no mean feat. It usually takes many months and becomes the primary focus for a sizeable team, consuming a considerable amount of resource and effort. For most in the team that is their sole occupation.

In effect the sunk cost of these endeavours weighs heavily on the decision maker. Can one really invest so much time, effort, and money, then say no to the deal because the projected returns have diminished?

There is also the problem that adverse items may accumulate gradually during the course of the deal.

On their own, each of these issues may not merit terminating the deal. But taken together they become a problem.

Added to this is the concern that if you don’t buy the target, then a competitor might and give them an advantage in a competitive the market, or at the very least create additional difficulties for your firm.

This may be the one and only chance to acquire the target. If that is missed then the opportunity is unlikely to arise again.

These factors can combine to create a fear of missing out. The rationale of ‘buying to own forever’ starts to overshadow any business sense.

But leaders should beware, it is a fine line between having the determination and focus to push a deal through the many complexities and obstacles which arise over a long period of time, and ignoring the unwelcome signs of a bad deal.

At what point do you change your decision? That is a more difficult question and one that many CEOs find themselves unable to answer, despite a deal becoming bad.

4 The role of denial in bad acquisitions

In a recent survey, 64% of CEO’s were said to be happy with their acquisitions. Yet this does not correlate with the number of deals that destroy value, rather than creating it.

Could it be that they are unaware of the problems those deals have caused? Or are they in denial about the adverse impact of their decisions?

Businesses rarely admit mistakes – not unless they are forced to. Announcements about an acquisition will always remain positive until the problems are inescapably obvious.

This can also shape internal behaviour patterns, as senior managers may not ask – and therefore know – what the outcome of an acquisition is.

It is sensible to review acquisitions after one to three years to identify lessons to be learnt. However, some corporates simply do not do this.

Others reserve the process for smaller acquisitions, on the grounds that larger acquisitions are a matter of strategy. Such thinking neatly sidesteps any accountability.

The strategy is expected to win in the end, so it is cited as a justification to destroy value in pursuit of a greater vision.

However, this argument does not hold water. Evidence shows major acquisitions destroying shareholder value for the next 10,15 or 20 years.

Of the largest 10 deals ever done, the only deals which avoided major long term value destruction were those in which the destructive acquisition was then sold off. In the remainder, shareholders are still suffering the consequences.

Indeed, one advantage with smaller deals is that the outcome is rarely apparent externally whether good or bad.

How to remain objective during acquisitions

M&A invariably causes much excitement, passion, and emotion. These are factors which are likely to result in suboptimal outcomes.

Private equity has few fans, other than its investors who generally do well. Their buy-improve-sell model requires much discipline and objectivity to hit their target returns.

This involves building a detailed model of the various factors such as price, cash flows, and benefits from improvement work.

If the model does not produce a return in excess of their threshold target, they pull out and walk away. They generally avoid chasing prices higher or over estimating benefits to justify a higher price.

Having worked with private equity, I have generally found they halve the estimated financial benefits of any improvements when adding them to the model.

This reflects the practical difficulty of implementing savings and increasing sales. They are naturally conservative in their approach as a bad outcome is highly visible and raising future funds from investors will then be difficult.

When private equity firms depart from their usual approach of objectivity, careful assessment of risks, and conservatism, that is when they make mistakes. M&A is not for enthusiasts; it is for objective thinkers.

Further reading:

Mergers and acquisitions: four steps to deliver value

Four rules to avoid failure in mergers and acquisitions

Six tips to find hidden benefits in tech M&A

Deliveroo investors are paying the price amid takeover

John Colley is Professor of Practice in Strategy and International Business at Warwick Business School and author of The Unwritten Rules of M&A: Mergers and Acquisitions that Deliver Growth - Learning from Private Equity.

He teaches Mergers and Acquisitions on the Executive MBA and Executive MBA (London), the Global Online MBA and Global Online MBA (London), the Accelerator MBA and the Full-time MBA. 

Learn how to add value and avoid common pitfalls in M&A with the three-day programme, Mergers and Acquisitions: How to Maximise Success, at WBS London at The Shard.

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